The Risk to Equities from Rising Rates

Wednesday, February 08, 2006 | 05:16 AM

If risk-free returns on CDs have been returning performance equivalent to risk-laden returns on S&P500, the question some investors are asking themselves is "Why take the risk?"

That's the issue Justin Lahart explores (inadvertantly) when exploring the issue of how low rates actually are:

"Even though the Federal Reserve has been raising rates since June 2004, they're low historically. Over the past 50 years, the fed-funds rate (the main overnight rate the Fed controls) has averaged 5.75%. Today's [4.5%] hardly seems onerous . . .

Cd_v_spx_wsj

Ed Hyman, chief economist at research firm ISI Group, points out that those low, long-term yields are also a signal that returns on other investments are expected to be low.

Consider stocks. Last year, the S&P 500 index had a total return (including dividends) of 4.9%. Meantime, the average rate on a six-month certificate of deposit was 4.6% in December. They're so close, you can imagine investors socking a bit more money in (safer) CDs and a bit less in (riskier) stocks.

These low expected returns have ramifications on economic prospects. It gives companies less reason to spend money on the equipment or new hires to expand. It gives venture capitalists less reason to fund budding businesses. In short, it discourages investment, and makes economic growth harder to come by as a result.

Today's low short-term rates may be plenty high."

Interesting stuff . . .






Source:
Interest-Rate Lowdown
AHEAD OF THE TAPE
By JUSTIN LAHART   
January 11, 2006; Page C1
http://online.wsj.com/article/SB113694267958643312.html

Wednesday, February 08, 2006 | 05:16 AM | Permalink | Comments (4) | TrackBack (0)
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Comments

Why take the risk?

Because longer term, the S&P returns >10% with dividends doesn't it?

If you look at it too short-term, as in this case I believe, sure it fits the case. But it's like saying the Dow was down 50 points today, why invest in the Dow when I made $1.50 in interest today in my savings account.

Posted by: Michael | Feb 8, 2006 11:42:53 AM

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